Information about publication

Climatic tipping points and optimal fossil fuel use

Gustav Engström and Johan Gars. 2015.

Abstract:

The economics of climate change is characterized by many uncertain-
ties, including climate dynamics, economic damages and potentially ir-
reversible climate catastrophes. Using an optimal growth model of a
fossil-fuel driven economy subject to a climate externality and potentially
irreversible climatic events, this paper contributes to the understanding
of how the risk of such events impacts on optimal fossil-fuel over time.
Catastrophic events are modelled as irreversible abrupt changes in the
underlying system dynamics. Our analytical results reveals the existence
of three important eects concerning optimal fossil-fuel use; i) the exis-
tence of such events will increase the present value of marginal damages
which works to postpone extraction ii) the probability of an event occur-
ring sometime in the future also lowers the value of using fossil-fuels in
the future which creates incentives to use more of the resource today iii)
if the probability of a regime shift increases in fossil-fuel use this creates incentives to further postpone usage. Depending on the specication of the hazard rate process, which of the above eects dominates and the as-
sumptions made regarding the abundance of fossil-fuel reserves, optimal
extraction may become either increasingly precautionary or aggressive as a result of including potentially catastrophic events in the model.